What's Really Behind Goldman's Facebook Investment

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Talk about a social media bubble!

Facebook has raised $500 million from Goldman Sachs Group Inc. (NYSE: GS) and Russian investment firm Digital Sky Technologies, which implies that the social media darling is valued at a staggering $50 billion.

This reminds me of the valuations being assigned to Internet companies leading up to the "dot.bomb" crash. There's no way a company that relies on nothing more than bits of information – the vast majority of which are summarily ignored by the community that supposedly finds it so compelling – should have a valuation approaching The Walt Disney Co. (NYSE: DIS), equal to The Boeing Co. (NYSE: BA), and greater than Time Warner Inc. (NYSE: TWX).

Still, for the sake of argument, let's play along and suppose that the $500 million capital infusion is for real and that the $50 billion valuation it implies is correct. Then the question becomes: What does the transaction say about Goldman Sachs, which arranged the deal, and the regulators supposedly overseeing it?

Nothing good that's for sure.

The way I understand the deal is structured, Digital Sky is investing $50 million and Goldman is investing $450 million for a stake in Facebook that they plan to package and resell to investors. That makes Goldman a principal in the deal, which means in very plain terms that they can no longer claim any obligation to the investor (their customer) who bought the other side. It's important to keep that in mind.

Now let's move on to the valuation.

I wonder exactly what the Russians are getting for their money, because Facebook is still a private company, which means nothing it does is reportable. 

Reports suggest that some 1/12 of the world's population gathers together on the popular social networking site – which now ranks ahead of Google as the world's most-trafficked Web site – and that the collection of human data that's stored there makes Facebook the largest, self-fueled marketing database in human history.

That point is well taken.

But exactly what is Facebook going to do with all of that data? The presumption appears to be that Internet advertising is the "golden egg." Unfortunately, that theory's been dead – or at least passé – for years.

Even if there are products for sale, which to date is not the case, the backlash that's building about sharing sensitive information online could kill the company overnight – $50 billion or not. Then there's the fact that people are losing interest in the two-way drivel that at the end of the day becomes nothing more than another e-mail platform cloaked under the guise of "social media."

Sure, Facebook has a lot of people trolling through its site, but the important question is how do they monetize that traffic? In other words, they face the same old dilemma salesmen have faced since the beginning of time: How do you convert the "tire-kickers" into buyers.

Personally, I think the more interesting aspect to this transaction is Goldman's involvement. By helping raise $500 million, the firm is doing more than simply pocketing huge fees. Goldman is positioning itself for the eventual initial public offering (IPO), which this fund raising postpones – at least for the moment.

It would not surprise me in the least to learn that Goldman Sachs has a contractual right to be the manager of Facebook's IPO. If that proves to be the case, it would mean Goldman has effectively fronted Facebook $450 million for the privilege of orchestrating the company's forthcoming IPO – and then gotten its money back by selling its stake in the company off to high-end clients looking to get a piece of the social media giant. 

But let's not get ahead of ourselves.

For the moment, Facebook remains a private company and does not have to discuss anything it does – such as the costs it incurs, the mounting complaints regarding personal data, or where it spends its money. Nor does Goldman have to disclose how it's profiting from the deal or acknowledge related trading positions it's establishing in the process.

Speaking of which, the other thing that catches my attention when it comes to this entire matter is that Goldman reportedly wants to create another of its "special investment vehicles" – one that would allow a select few additional investors to put as much as $1.5 billion into Facebook. That would mean more fees for Goldman, while also ensuring that it keeps its "investors" outside of the Security and Exchange Commission's (SEC) public disclosure rules.

Sound familiar?

It should, given that special investment vehicles and limited disclosure played a key role in creating the financial crisis that's still not over and from which Main Street is still reeling. Never mind the irony that – thanks to a taxpayer funded bailout – Wall Street bonuses are bigger than ever and that it's already back to business as usual.

All is not lost, though.

Several sources are now reporting that Facebook may already be over the 499-investor limit threshold that requires public disclosure. If this is true, Goldman and Facebook could both be dragged kicking and screaming into a hostile court of public opinion that will highlight just how stacked the deck is.

And speaking of stacked decks, let's talk about conflicts of interest for a minute. According to the one page investment profile Goldman sent to its wealthiest clients, "GS Group may at any time further reduce its exposure to its investment in Facebook without notice to the fund or investors in the fund."

If that's not a conflict of interest, I don't know what is.

This clause would allow Goldman to hedge or trade against the very same clients it's now putting into the deal. That, in turn, means the firm can exit or burn the house down without warning!

Of course, I love the small print, which also states that the content of the offering "is not guaranteed as to accuracy or completeness." Maybe that's why there's another line near the very bottom that advises potential clients: "Do not contact Facebook."

Could you imagine investing your hard earned money into a prospective stock offering and agreeing not to talk to the issuer to do due diligence? What ever happened to the Prudent Man Test – or at the very least common sense?

Sadly, though, my guess is that Goldman will find a way to steer clear of the entire shooting match at all costs to avoid disclosing its business practices – the same way it paid a $550 million fine last year to settle charges of securities fraud related to mortgage investments.

Incidentally, the SEC was very proud of its pound of flesh and the $550 million penalty –apparently they didn't realize that Goldman booked more than $13 billion in the process.

Apparently, the pigs still wear lipstick and the regulators still haven't got a clue just who's running the show these days.

[Editor's Note: Money Morning's Keith Fitz-Gerald clearly understands Wall Street's tricks, and knows how to exploit them for profit. He also has an unrivaled understanding of global markets that stems from two decades' worth of boots-on-the-ground involvement with key markets. In his Geiger Index advisory service, Fitz-Gerald brings all of his experience and insights to bear for subscribers. His scorching track record speaks for itself. To learn more about Geiger, please click here.]

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About the Author

Keith Fitz-Gerald has been the Chief Investment Strategist for the Money Morning team since 2007. He's a seasoned market analyst with decades of experience, and a highly accurate track record. Keith regularly travels the world in search of investment opportunities others don't yet see or understand. In addition to heading The Money Map Report, Keith runs The Geiger Index, a reliable, emotion-free guide to making big money and avoiding losses, and Strike Force, which aims to get in, target gains, and get out clean. In his weekly Total Wealth, Keith has broken down his 30-plus years of success into three parts: Trends, Risk Assessment, and Tactics – meaning the exact techniques for making money. Sign up is free at totalwealthresearch.com.

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  1. Jeff Pluim | January 7, 2011

    Thank you Keith, for saying what should have been shouted from the roof tops. I am truly surprised that you are the only one I've seen, or heard of, who is calling this deal what it really is.
    My feeling is that those gangsters at Goldman, and the rest of these Wall Street fat cats should have been, and should now be charged criminally for fraud. Putting a small disclaimer at the bottom of the deal should not absolve these crooks. And to say that investors may not contact Facebook in order to do their due diligence, well come on!!!!!! The regulators are beginning to look more and more like they are in the same boat as the crooks.
    And any hedgefund manager or other person who is managing the money of others, who invests in this scheme should also be drawn up on the carpet for failing to do the due diligence necessary to protect their investors.

  2. Barney Watkins | January 7, 2011

    Excellent brief of what we all are having to accept about black ethics of Wall Street and who is the real culprits of destruction of this country. I have reached the limit of my tolerance for market manipulation and corruption which this article clearly is an example of. Thank You Money Morning, keep up the good vigilence!

  3. Werner Strohmeier | January 7, 2011

    Thank you for this fundamental analysis. It sounds pretty alarming and wont entice me – a non US citizen nor resident – to put my money into the US stock market. It looks too crooked, perhaps no more than elsewhere in the world, but at least you have warned people and I am grateful to you for doing it.

  4. King Ralph | January 7, 2011

    Farcebook would be a more appropriate name for the company.

  5. G Haber | January 7, 2011

    THE MORE THINGS SEEM TO CHANGE , THE MORE THEY REMAIN THE SAME .
    DIFFERENT JACKET SAME BOOK!!!!!!!!!!

  6. Carla | January 7, 2011

    You GO Keith! Excellent analysis.

  7. Alex Moll | January 7, 2011

    It is refreshing to read clearly reasoned and expressed opinion on matters like this, where the principals rely on convoluted mechanisms &
    very small print to hide their chicanery. It is sad that they also seem to be able to rely on the regulatory agencies to turn a blind eye. No wonder investors are giving up on the US markets and looking elsewhere.

  8. Shawn | January 7, 2011

    Well done, couldn't have said it better…

  9. Mick A | January 7, 2011

    Great article…One small detail that should be mentioned…check out the facebook family tree..back to its roots…the CIA are behind it's creation. It is the best information gathering tool they have ever had…do you believe any information they have on you is safe? The CIA is the worst and most corrupt criminal organisation on planet earth…that's a big call, putting them ahead of Goldman Sachs, JP Morgan, the Bilderberg group, Rockerfeller and the Federal Reserve. The CIA (Criminals In America) are in bed with all that is bad…ask JFK,Martin Luther King, John Lennon, Malcolm X..the list goes on. Want to lose your money…let Goldman Sachs get their hands on it….

  10. Ron Crider | January 7, 2011

    Does anyone here know that Goldman-Sachs' ultra-high speed trading computers are located in the very same deep underground vault as those of the (less up-to-date) trading computers of the New York Stock Exchange, and that Goldman's computers are networked directly into the NYSE computers, intercepting and skimming split-second profits off every trade? Just like the Facebook deal in the article today, this fact begs for much more sleuthing and exposure. Entities of this ilk have not only a "rule the world" mentality, they have made it a private reality. Regards, Ron Crider

  11. Vincent F. Celli | January 7, 2011

    Keith: I just came from watching the documentary "Inside Job" narrated by Matt Damon. It is excellent and depressing at the same time. I would urge any of the readers of Money Morning to see it. It makes it quite plain that there are still crooks on Wall Street and nothing is being done to reigh them in.

    Goldman-Sachs is still the fox in the hen house.

    Any time you want to propose remedies for lack of regulation on the street that I could forward to my congressman I will be first in line to do so.

  12. hadenough | January 8, 2011

    mick a . you said if you want to loose money let goldman sachs get their hands on it" good bye FUTURE FUNDS AUSTRALAI.. KEEP AND EYE ON A CERTAIN EX POLITICANS BANK BALANCE. AND THAT WILL TELL YOU HOW GOOD HE IS MANANAGING THESE FUNDS FOR HIS EMPLOYEE, G.S.. (you might have to go to the cayman ilsands. or .ect…ect ..ect to find that)
    Maybe, just maybe, one day the dumbed down public will start asking questions and more importantily they will demand answers. but i dont think i will bother holding my breath.

  13. Vasilis | January 9, 2011

    Way more than the 1/12 of the world's population "likes" to the article and the "comments"…

  14. le | January 10, 2011

    The Goldman Sachs plus Facebook plus a small Russian company cross involvement, only serves to remind that the world financiers/bankers are worldwide and growing their assets to continue with world domination.

    Soon they will attempt to eliminate all those who cannot afford to buy into their schemes.
    For them it is a natural point of division.

    PROLETARIAT WAKE UP.

  15. Jareau | January 10, 2011

    "CIA"? … "Deep underground vault"? … TYPING IN ALL CAPS?… folks, let's not get ahead of ourselves here. Unproven claims, use of descriptive, possibly imaginative text, and emotion have no place in this conversation…. The CIA comment is unfounded – conspiracy theory, at best. The "Deep underground vaults" comment is an exaggeration of what very well may be a standard, multinational server-farm that is as simple as a few servers in Newark, NJ – 3 blocks from Rutgers University, some more in London, and a few in Tokyo, kilometers from the Tokyo Tower.

    Folks, the issue here is the fact that regulatory agencies, again, do not understand the mathematics behind what is driving these investment vehicles. They approve their use, without knowing how to properly compute their value, the risks associated, and worse, who the rightful owner is.

    This, as Keith aptly mentioned, is simply a case of Wall Street creating yet another investment vehicle which the general public does not understand, yet believes will be profitable.

    In my opinion, it's manipulative, wrong, and should be criminally punished.

    Keep in mind, Goldman is not a single person, it's a hand full of people sitting in a room, conjuring up ways to make more money. Those are specific people, who can be named and should be held accountable.

  16. Lenet Compton | January 11, 2011

    I thoroughly enjoyed this article and associated comments. I have felt for years that Goldman Sachs is not a company to do business with and am almost done shifting my investments. I ask you though, who is really to blame? I think change demands should be directed toward the root cause of any problem. In the case of our financial melt down I believe the root cause is the regulatory body (regardless of who they are influenced by) and will share that thought with my Congressional representatives.

  17. Johann | January 18, 2011

    Didn't these guys get into trouble for exactly the same thing before during the big meltdown when Rubin and Paulson were taking their turn in the revolving door? Is this deal the reason President Obama "nominated" Rominger to be the new SEC watchdog after she was ready to retire? Enquiring minds..etc

  18. Washington Owuor | January 29, 2011

    Wow my fisrt day looking into stocks investments and I ran into this article and men am I shocked and glad at the same time. But this was very insightful and very enjoyable to read, I wonder if I could get banned from facebook by sharing this there.

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